There’s never any lack of confusion when it comes to the topic of estimating Remaining Economic Life (REL). For the most part, this confusion centers on the misunderstanding that REL is reflective of the number of years a physical structure is expected to last. Just think about it: From a mortgage perspective, this concern is reasonable. Who wants to make a 30-year mortgage on a residential property if the physical structure isn’t expected to last more than 20 years?
From an appraiser’s perspective, the REL is part of a simple calculation used to estimate depreciation for the cost approach. The REL is the difference between the estimated total economic life and the estimated effective age. A well-maintained property has a low effective age and a high REL, whereas a property in disrepair will have a high effective age and a low REL. In short, it is a quick and easy way to estimate straight-line physical depreciation.
However, to fully understand REL and how users like HUD employ this information, we also need to consider the following:
-PHYSICAL LIFE The total period a building lasts or is expected to last
-ECONOMIC LIFE The period over which improvements to real property contribute to property value
As such, a structure that is sound and in good physical condition with many years of physical life remaining may reach the end of its economic life if its remaining years of physical usefulness are not profitable. Some highly desirable areas can have older residential structures that are well maintained and in good condition. However, their remaining economic life can be low if it is more profitable to remove the dated improvements and build a new structure that provides the modern features and amenities the market demands.
From HUD’s prospective, the REL needs to be reflective of the number of years the property is expected to remain competitive in the market. To accomplish this, HUD suggests the appraiser consider:
-How the property fits into its surroundings
-Trends in the neighborhood
-The physical condition of the property
The HUD handbook states that the useful life of a building has come to an end when:
-The building can no longer produce annual income or services sufficient to offset maintenance expense, insurance and taxes to produce returns on the value of the land.
-Rehabilitation is not feasible.
Given this information, one needs to consider whether or not a property with obvious deferred maintenance needs to have a low REL. From HUD’s viewpoint, maybe not. If the subject is considered typical for the area and trends indicate that properties with deferred maintenance are renovated, it is reasonable to consider that the current improvements and property type will be useful for many years to come.
In closing, I feel it is important for appraisers to understand how clients are using the information provided in reports. In this case, per HUD, the most important consideration in estimating REL is the estimated time the current improvements are expected to contribute value to the
property.
